How Banks Judge Your Application

Traditionally, banks focused more upon collateral than any other factor in making loans; however bankers now claim that lending competition has forced them to focus more on a business's ability to repay the debt as it comes due, rather than the collateral securing the loan.

Belt and suspenders. For short-term debt, the cash flow statement and projected income and balance sheets will be most relevant. The institution will want to know what the funds are being used for and whether the business's earnings will be sufficient to repay the loan. Banks do not want to enforce their rights to foreclosure or repossess collateral, and such actions merely highlight a poor lending decision. Nevertheless, banks still place considerable emphasis upon collateral, especially when the projected cash flow of the debtor is as fragile as it often seems to be in a small business.

The lender will dictate the repayment terms of your loan, but your explanation of the source of the funds for repayment and how you will manage your overall debt will be crucial to the lender.

Work Smart Some banks will require that your financial statements be prepared or reviewed by an accountant. If no such requirement is stated, you may be able to do much of this financial planning yourself; however, local lenders may find your proposals more credible if a reputable local CPA or attorney -- that the lender already knows -- has participated in reviewing or preparing your financial statements. Lenders will sometimes contact accountants and financial advisors directly to discuss a business plan or a financial statement. These conversations can have a powerful influence on the outcome of a loan application.

Rogue ratios. Some lenders rely heavily upon certain financial ratios, such as debt-to-equity, quick ratio, current ratio, etc., in assessing the creditworthiness of a prospective borrower. With many small businesses, however, these ratios may misrepresent the overall value of the enterprise. The most important assets of a small business are often the experience of the owners, the potential value of prospective customers, and other non-balance sheet items. In addition, because of tax or strategic business purposes, some entrepreneurs may choose not to list assets on personal statements or they may list important assets on the financial statements of different businesses that they own. In these situations, the financial ratios of the borrowing company may be understated.

Work Smart If your loan application is denied, find out as much as you can about the review of your loan, which factors hurt you the most, how you can improve your chances for obtaining a loan in the future, and whether the bank would consider being a secondary financier if a primary lender were obtained.